Deflation: It Happened In 1st Quarter Moderate Inflation Foreseen For Remainder Of 1986

May 18, 1986|by DAN SHOPE, The Morning Call

For most young Americans, inflation is an evil word. They watched President Richard M. Nixon call for wage and price controls to stop double- digit inflation. They even may have collected one of President Gerald Ford's WIN (Whip Inflation Now) buttons from the mid-1970s.

The high rate of inflation during the Carter Administration in the late 1970s helped Ronald Reagan to victory in the presidential campaign of 1980. And an improved economy and lower rates of inflation helped President Reagan win a second term.

So when the consumer price index recorded negative inflation - or deflation - in the United States during March and April, most young Americans believed it was time to celebrate.

Well, not exactly.

"Deflation is not a desired economic concept," said Kamran Afshar, assistant professor of economics and business at Moravian College. "We had it in the 1930s, and it was surely not desirable then."

For older Americans, Afshar said, deflation means the stock market crash of 1929 and the ensuing Great Depression. It means soup lines, runs on banks and the lyrics, "Brother can you spare a dime?"

Rest assured, Afshar foresees none of this happening today.

Nevertheless, March's rate of -1.7 percent inflation (or 1.7 percent deflation) is the first extended deflation since June, 1962, when it was -.2, Afshar said. Using his computer, which has figures dating back to the early 1950s, Afshar couldn't find a deflation figure larger than March's.

"Basically, the major cause of deflation has been the drop in oil prices and the reflection of the drop of oil prices on the economy," Afshar said. "The impact on oil prices has been trickling down through the system and part of it has been enjoyed by the consumers. It's now adjusting a little upward and the leveling of the price of oil can look to be relatively stable."

According to Afshar, the price of crude oil was $13.60 per barrel early last week. He said it had dropped to about $9 early this year from $28 last year.

He added that wholesale prices for fuel oil in New York City were 46.6 cents per gallon last week, compared to 72.75 cents per gallon last year. Wholesale unleaded gas in New York had dropped to 55.5 cents per gallon last week from 82.35 cents per gallon last year.

"The present economic environment is markedly different from that which prevailed in the late 1970s," said Afshar. "Inflation exceeded 9 percent in 1979 and peaked at 13.3 percent at the end of 1980.

"Inflation continued at high rates until 1982, when it dropped to 4.9 percent, starting an era of low inflation. But since January, the rate of inflation has taken a nose dive. As of March, the rate dropped to 1.7 percent deflation - a decline in consumer prices.

"It must be emphasized that this extremely low rate was only over February and March. By increasing the period of analysis to the last 12months, one can observe an inflation rate of 2.3 percent, a level which clearly signals even lower inflation this year."

Continued deflation will cause situations most young Americans never experienced. It will obviously mean decreased revenues and lower profits for sellers. With less profits, there will be less taxes collected.

As farmers and those in the oil business have found, dropping prices bring declining values for land and other collateral needed for bank loans. And if prices continue dropping, many businesses may be forced to stop investing in new equipment or facilities because they won't be able to make a profit.

"If negative inflation continues, we could reach a point that it won't be profitable for producers to make anything," Afshar said. "Seeing the negative margins, they would have little interest in continuing.

"The last time this country had continued negative inflation was the 1930s, when we had the Depression. But I don't even see a chance of that happening. Nationally, the economy looks robust at this moment."

Actually, Afshar said the recent increase in oil prices will help keep the economy from falling into a generalized deflation.

"We're coming down one end of a roller coaster," Afshar said. "Maybe we're coming down to a more natural market level for oil. But let's not read too much into it. I don't think there's much of a chance to have the price go above $15 per barrel. But if the (OPEC) cartel can get its act together, it will still have 45 percent of non-Communist oil production in its hands. It will still be able to move prices up.

"It's wishful thinking to hope that the war will go away, but if Iran and Iraq end their differences, prices could fall again. Both were heavy oil producers, and both now have devastated economies now. When the war is over, they will need cash desperately. If their oil industries recover, they would inject 4-5 million barrels on the market per day, drastically lowering prices."

But until a truce is called between Iran and Iraq, Afshar sees gasoline prices stabilizing and the consumer price index reaching and stabilizing at 2 to 4 percent inflation before the end of 1986.

"These are considered benign inflation rates," he said. "The economy is not totally synchronized right now, and this has caused the negative inflation we're seeing now."